economic update
By David Marshall, Chief Financial Officer

Two offshore themes unsettled global markets over the past month: sovereign debt in Europe and a policy tightening in China. The combination of these events caused a ‘flight to quality’ as investors piled into safe haven US Treasury bonds and closed off risky ‘carry trades’. The resultant capital flow caused a sharp appreciation of the US dollar notably against, the Euro and UK Stirling.

However, by early March, both Greece and Portugal had announced stringent austerity packages with the objective of meeting EU budget deficit targets of 3% of GDP and Germany and France offered implicit support, reducing fears of sovereign defaults. Commodity prices and the Aussie dollar also rebounded.

For the Reserve Bank, the February “no change’ decision allowed time to consider the impact of the tightening in lending rates since October. By March, however, with offshore concerns receding and the economy strong, the RBA decided to tighten by another 25 bps to 4%. National Australia Bank expects cash rates to rise further in 2010 to 4.75%, based on their own surveys, plus Retail Sale and ANZ job ads data being strong. According to NAB, it also based its decision squarely on the strength of the domestic economy, where the fall in unemployment to 5.3% - within sight of the Non-Accelerating Inflationary Rate of Unemployment (NAIRU), regarded as below 5% - and a range of business surveys “suggest growth in the economy may have already been at or close to trend for a few months”.

The Australian economy notched up a strong second half of the year, growing by 0.9% in the December quarter after growth of 0.3% in the September quarter. There were also some upward revisions to previous quarters’ growth with the result that growth over the course of 2009 was not the 2.3-2.4% expected but 2.7%. Growth was broad-based across sectors but strongly supported by fiscal stimulus.

Commentators at Australian Markets Monthly believe that the complexion of growth is set to change from here. They indicate that public investment in schools will likely peak in the current half, while private investment especially from the dwelling construction up-cycle as well as resource-based investment will become increasingly prominent drivers. The improvement in the labour market is also likely to support growth in household disposable income and consumption.

Source: Australian Markets Monthly, March 2010, National Australia Bank